Analyst: Euro / Pound Sterling Rate to Rise on Political 'Arm Wrestling'

The Euro is likely to soon embark on a concerted rise against the Pound argue analysts at a leading Scandanavian research house who believe a fresh bout of uncertainty will hurt Sterling.

Analysts at Danske Bank believe their forecasts for a stronger Euro to Pound Sterling exchange rate over a three month timeframe are likely to be met as the UK ruling class get set for a bout of ‘arm wrestling’ over the Brexit process.

The call by Danske comes on the day that the Supreme Court rules that only Parliament can trigger Article 50 of the Lisbon Treaty that takes the UK out of the EU.

With Parliamentary involvement comes the potential for weeks of bickering argue Danske, and this will have a notable impact on the trajectory of Sterling.

“It could be more problematic to pass the legislation in the pro-EU House of Lords where the Conservatives do not have majority, but it would probably create a constitutional crisis if the House of Lords tries to block or delay Brexit,” says Danske Bank Senior Analyst Michael Olai Milhoj.

The Supreme Court’s judgement says in section 122 that “What form such legislation should take is entirely a matter for Parliament”, which allows the Government to present a very short bill, which makes it more difficult for the MP’s to make amendments.

The Government have said they will present the Bill on Thursday January 26 - details here could be important for the Pound's outlook.

Both Labour and the Scottish National Party (SNP) have already said that they want to be heavily involved during the negotiation process.

“In other words, we will have some arm wrestling between the government and the members of parliaments in the coming two months ahead of the triggering of Article 50. However, it is worth noting that the EU is not bound by whatever strings may be attached by the UK government, so we still think we are heading towards a hard Brexit, as the UK cannot stay within the single market and get control over EU immigration at the same time,” says Milhoj.

As such Danske Bank have reiterated their call that they expect the Pound to come under pressure against the Euro as the triggering of Article 50 moves closer.

Danske target EUR/GBP at 0.88 in 3M but see risks skewed to the upside.

From a GBP into EUR perspective this equates to 1.1363.

Why is the Pound Going to Fall?

In Danske Bank’s estimations, UK economic growth will slow in 2017 following on from a “remarkably resilient” 2016.

However, while growth is forecast to slow, it will not fall into negative territory.

The decline in economic growth, forecast to be at 1.2%, comes as UK workers suffer a “de facto wage cut” owing to rising inflation which itself stems from the GBP’s huge falls during 2016.

However, the Bank of England is unlikely to react to the shifting economic landscape by cutting or raising interest rates. This should provide some stability for Sterling.

It is also however worth noting that according to Danske’s Purchasing Parity models, EUR/GBP is overvalued - it should be lower at £0.77.

Yet, risks are tilted to further Sterling weakness.

“Uncertainty about the future relationship between the UK and the EU since the Brexit vote has increased uncertainty about near-term FDI and portfolio flows into the UK, which, along with the large current account deficit in the UK, implies a significant risk to the GBP,” says Morten Helt, Senior Analyst at Danske Bank.

Helt says he sees potential for further GBP weakness in coming months as the triggering of article 50.

However, longer-term, Danske expect EUR/GBP to stabilise within the 0.84-0.88 range targeting the cross at 0.86 in 6M and 0.86 in 12M.

“As more clarification on the outcome of Brexit negotiations becomes available, we see a case for GBP strengthening due to positioning and valuation as Brexit uncertainty declines. This represents downside risk to our 6-12M forecast,” says Helt.